T

he Japanese government will increase its consumption tax from 5 to 8 percent in April and again to 10 percent in October 2015.

The last consumption tax rise occurred in 1997, from 3 to 5 percent. The tax increase will be made to implement the third component of the economic policies proposed by Japan Prime Minister Shinzo Abe under the so-called Abenomics concept. This strategy, launched by Abe in December 2012, consists of '€œthree arrows'€: fiscal stimulus, monetary easing and structural reforms.

The government said the purpose of increasing the consumption tax was to help reduce the central government'€™s outstanding debts. Conversely, in terms of government revenue, the policy is expected to boost tax revenue that will be used for social welfare programs.

There is a real possibility that the consumption tax hike will be followed by an increase in goods prices, which in turn can affect Japan'€™s economy, both domestically and internationally.

With the concept of cost-push inflation, in terms of the domestic economy, the increase in the prices of goods will lead to inflation. When it really happens, the government will find that one of its economic policies to achieve 2 percent inflation is on the right track.

On the other hand, for the people, the tax hike will reduce purchasing power, according to analysts. But the Japanese government has argued that fears of a decline in purchasing power could be anticipated by reducing individual income tax as compensation, so domestic demand can be maintained.

Internationally, increases in the prices of goods in Japan could have impacts on some countries that have trade and economic cooperation with Japan, such as Indonesia.

In the context of Indonesia'€™s economy, there are positive and negative effects that may result as an impact of the rising prices of goods in Japan.

In terms of positive effects, there is an opportunity for Indonesia to be chosen as a destination country by Japanese companies, when they intend to shift the production base outside of Japan, to avoid the price increase of their products due to the consumption tax hike.

Anticipating the possibility of weakening domestic demand could be another reason why Japanese companies may be prompted to relocate their production sites.

Meanwhile, the negative impact possibly affecting Indonesia'€™s economy after the consumption tax hike in Japan is the rising prices of goods imported from Japan. Based on data from the Indonesian Trade Ministry, in 2012 Japan was the second biggest non-oil exporting country to Indonesia after China, with US$22.7 million.

Imports from Japan are dominated by manufactured goods, such as machine parts and heavy equipment. The increase in prices of those imported goods will likely affect the cost of production of companies that still rely on machinery and heavy equipment from Japan in their production process.

Although we are not sure whether the consumption tax hike in Japan will affect Indonesia'€™s economy, it would be better if the Indonesian government prepared some measures in the event that impacts
are felt.

Such measures, such as improving the investment climate in Indonesia, are expected to attract Japanese companies who want to move their production base outside of Japan.

On the other hand, to avoid the risk of higher prices of goods imported from Japan, we should try to find another country that can supply similar goods and reduce Indonesia'€™s dependence on imported goods from Japan.

The writer is manager of Bank Indonesia'€™s Tokyo representative office. The views expressed are his own.